In a decision dated 19 July 2010 (case reference: 7 K 1154/09), the lower tax court of Munich held that royalty expenses of an EU-based licensor may not be taken into account in determining the withholding tax base for royalty payments of a domestic licensee, according to the principles enunciated in previous decisions of the Court of Justice of the European Union (ECJ) in the Gerritse (C-234/01), Scorpio (C-290/04) and Centro Equestre (C-345/04) cases.
In the case, a German TV network station (claimant) paid royalties for licensing film distribution rights from a Luxembourg-based entity. The TV station itself had licensed the rights from two German entities and had thus incurred licensing costs.
Even though the ECJ held in previous cases that the business expenses of a service provider that are linked directly to its activities should, in principle, be deductible when calculating the tax to be withheld by the domestic payer, the local court of Munich held that where a foreign licensor incurs licensing expenses and the applicable tax treaty provides for a 5 % withholding tax on the gross payment, such costs do not need to be taken into consideration because the tax rate applied to the payments was much lower than in the cases previously decided (where a tax rate between 15 % and 25 % applied) and double taxation was ultimately eliminated by a credit of the German tax paid in Luxembourg under the treaty.
Moreover, the court did not characterize the licensing costs of the Luxembourg licensee as directly linked to the licensing of the film distribution rights to the claimant within the meaning of the Centro Equestre decision because the costs were incurred by obtaining the right rather than the actual activity of granting the right to the claimant. Earlier this year, the tax court of Lower Saxony had taken a similar view on this question (case reference: 6 K 511/06, see Deloitte Tax-News).
Irrespective of the two court decisions on this matter, the exclusion of license costs when determining the withholding tax base for royalty payments still seems to be questionable and the view of the BFH remains to be seen. The decision of the tax court of Lower Saxony as well as the decision of the tax court of Munich have been appealed by the taxpayers and are now pending before the BFH (case references: I R 32/10 and I R 76/10).
EU/EEA resident taxpayers that have incurred a final withholding tax on royalties in Germany should consider filing protective claims if they incurred significant costs that can be regarded as having a “direct connection” to the royalties.
If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
